Back to basics: taxes

George W. Bush's first economic task, implementing his bold tax-cut gambit, represents the culmination of a recurring clash in modern American politics - a bedrock ideological divide over the direction of the nation's finances.

Big tax cut? Or a smaller, more targeted one?

When Federal Reserve Chairman Alan Greenspan testifies in the Senate tomorrow morning, both parties will be studying his words for a nod of acceptance - or a hint of hesitation.

Republicans have renewed calls for an across-the-board cut that would, by their definition, give some of the growing budget surplus back to the people who created it. Democrats have argued for more fiscal "prudence," suggesting the nation shouldn't risk its prosperity in one giddy action. In the Clinton years, the latter course held the high ground.

Now, with the economy slowing, the Republicans are emphasizing again the Reagan-era, "supply-side" argument for lower taxes: The nation needs them to reignite the engines of American industry.

What now seems certain is that nation will get some sort of tax relief this year. The question is how much. The outcome could well set the tone for the early years of the Bush administration, just as a similar debate did for the Reagan presidency a quarter century ago.

A significant influence on the whole debate could turn out to be someone not aligned, nominally at least, with either camp: Mr. Greenspan.

His endorsement could be a big help to the White House in its drive for the $1.3 trillion, 10-year cut Mr. Bush campaigned on - or at least a sizable cut with some similarities.

Sympathetic voices arose in the Senate this week, with Phil Gramm (R) of Texas and Zell Miller (D) of Georgia introducing their own version of the Bush plan.

For any lawmaker, and especially for the president, a flourishing economy is crucial to political and real success.

Thus the most urgent Washington debate is over how to keep the nearly 10-year-old economic expansion going.

Nearly all economists agree that the Fed plays the key role in the business cycle, and that it acted correctly Jan. 3 when it dropped short-term interest rates half a percentage point to stave off too deep a slowdown.

Most Fed watchers expect the central bank's policymakers to trim rates further when they meet again in Washington next Tuesday and Wednesday. Some say the cut will be another half a percentage point, others a quarter point, cutting interest costs for millions of Americans.

Employing tax cuts to pep up a faltering economy is more controversial than utilizing monetary policy.

"The use of fiscal policy is not the best tool for short-term modest stimulation," says Dr. Paul Samuelson, the Nobel Prize-winning economist whose textbook has been read by millions of economics students.

One problem is that getting a tax cut through Congress normally takes about 18 months. By the end of that process, the economy may be thriving again. The tax cut might actually risk too much boom.

One tax move that would provide immediate economic stimulus would be a cut in withholding from employee pay packages. This does not require congressional approval. Indeed, Bush's father did it in 1992 in an effort to pep up a sluggish recovery.

Another idea floating around Washington would be to make any tax cut retroactive to Jan. 1. House majority leader Dick Armey of Texas suggested that step earlier this month. This assumes taxpayers will spend the money before it actually materializes in their pay.

Professor Samuelson does not rule out tax cuts or extra government spending as a useful boost when monetary policy has not worked adequately - as in Japan today.

At the moment, though, he figures that forecasts of a recession - a shrinking economy as opposed to merely slower growth - are "a little alarmist."

Democratic economists, meanwhile, quarrel with details of the Bush plan, especially if it is aimed at fighting recession. "The kinds of tax cuts Bush is proposing will not be too effective," argues Joseph Stiglitz, who was chairman of the Council of Economic Advisers for President Clinton in 1995. Too much of the savings would go to the rich, who tend to save rather than spend, he says.

Extra savings would slow the economy, not revive it, he argues.

THE supply-side theory is that slashing marginal tax rates for rich as well as poor encourages extra effort and investment by those getting the tax benefits. This expands the economy, and benefits filter down to lower-income groups.

The last broad cuts in tax rates, spanning all income brackets, came in 1986 and 1981, under President Reagan.

In the weeks ahead, it will likely become clear whether Bush can score a similar victor, or must compromise with Congress, especially Democrats, on his goals.

Within the administration, Treasury Secretary Paul O'Neill is seen as a pragmatist, willing to deal to get a bill through. Bush and his chief White House economic adviser, Lawrence Lindsey, are regarded as somewhat more ideological, with a supply-side bent.

One course would be to isolate some of the more popular proposals - such as trimming back or eliminating estate taxes, improving tax breaks for retirement plans, and reducing the "marriage penalty" (by which many couples pay more married than they would single). These stand a good chance of being passed relatively quickly with considerable Democratic support in Congress.

If a broader bill passes, "rate cuts for the rich will be much less" than Bush proposes, predicts Harald Malmgren, a Washington economic consultant.

(c) Copyright 2001. The Christian Science Publishing Society